Cullen, J:—With respect to the facts of this case there is little if any disagreement. What is in dispute is the interpretation to be given to the actions taken.
The plaintiff is a very successful carpet retailer. On October 15, 1976 the plaintiff entered into a memorandum of understanding with a corporation called Talcorp Associates Ltd (Talcorp), pursuant to which Talcorp in 1976 purchased on behalf of itself and the plaintiff 1,200,000 shares of Bad Boy Limited — one-half for each — at a price of $3 per share for a total purchase price of $3,600,000. The evidence of Mr Jerry Van, and I accept it after hearing him, is that in order to pay its share of the purchase price, namely $1,800,000, the plaintiff borrowed from Taicorp the sum of $900,000 and established a line of credit with the Bank of Montreal to borrow the balance. The evidence and the statement of claim are at variance as to the actual amount borrowed and the amount paid directly by the plaintiff from its own resources but it is of no consequence here.
At the time of its purchase, Bad Boy Limited had substantial non-capital losses available for deduction for tax purposes against future income under the provisions of paragraph 111 (1 )(a) of the Income Tax Act. Certainly there can be no doubt that part at least of the reason for acquiring Bad Boy Limited was the expectation that it would enable the plaintiff to reduce some of its profits before taxes by using the available running non-capital losses account of Bad Boy Limited.
The memorandum of understanding provided, inter alia, for the purchase by Bad Boy Limited of the assets of Factory Carpet, which was a subsidiary company of S B Diversified Limited (a holding company) at the time, at a purchase price not to exceed $4,000,000 of which $1,800,000 was to be payable in cash on closing. It was intended that forthwith after the transfer of assets of Factory Carpet to Bad Boy Limited the $1,800,000 amount received on the sale of such assets would be used to retire the plaintiff’s liabilities on the purchase of the Bad Boy Limited shares and to release the two principals from personal guarantees. The transfer of the assets was never effected. In 1977 Bad Boy Limited was placed in receivership and its shares became worthless.
The original agreement between the plaintiff and Taicorp contained a put option which allowed Taicorp to put its 600,000 shares of Bad Boy Limited to the plaintiff at a predetermined price. During the 1978 taxation year Talcorp exercised its put option and the plaintiff was required to purchase the shares of Bad Boy Limited that were originally purchased by Talcorp. The put option was the subject of litigation eventually leading to the plaintiff purchasing the shares of Bad Boy Limited owned by Taicorp for $1,600,000.
This trial involves two actions, and the parties hereto have agreed to hear them on common evidence. Action cited as T-2799-81 relates to the purchase by the taxpayer of the original acquisition of 600,000 shares. Action cited as T-1717-83 relates to Talcorp putting its stock to the taxpayer. In my view the reasons for judgment cited here are the same reasons applicable to T-1717-83 and accordingly will be shown as such.
In preparing its tax return for 1977, the plaintiff valued its inventory of shares of Bad Boy Limited at the lower of cost or market as permitted under subsection 10(1) of the Income Tax Act. As a result of this inventory revaluation, a non-capital loss was shown in the 1977 taxation year which reduced taxable income to nil and created a non-capital loss carry-forward of $1,564,144.
In preparing its tax return for 1978, the plaintiff revalued its inventory in shares of Bad Boy Limited acquired from Talcorp in 1978 and claimed a non-capital loss of $1,600,000 and deducted its legal fees arising from the litigation with Talcorp in the amount of $50,080.
The Minister of National Revenue disallowed the non-capital loss deduction arising from the revaluation of all the shares of Bad Boy Limited owned by the plaintiff and the deduction of the legal fees incurred in 1978. The Minister has also disallowed the non-capital loss deduction claimed by the plaintiff in 1979.
The nub of the controversy centres around the following propositions: 1. the plaintiff submits that the shares of Bad Boy Limited were inventory of the plaintiff and were properly valued at their fair market value (subsection 10(1) of the Income Tax Act);
2. the plaintiff submits that in purchasing the Bad Boy Limited shares the company was engaged in carrying on a business, an “adventure in the nature of trade”, and the loss from carrying on such business was properly deductible in computing taxable income;
3. the Minister of National Revenue has taken the position that the shares of Bad Boy Limited owned by the plaintiff in 1977 and the shares of the Bad Boy Limited acquired from Taicorp in 1978 were capital property and not an inventory of the plaintiff.
Thus, are they non-capital losses or capital losses?
The key to the plaintiff's case is of course contingent upon the intentions of the principals of Factory Carpet Ltd at the time they purchased the shares of Bad Boy Limited. Was it their “primary and/or secondary intention” at the time of the acquisition of the shares to resell at a profit after using up the non-capital loss carry-forward of Bad Boy Limited or was the selling of the shares the motivating factor (driving force) in the transaction? The Court is called upon, on a balance of probabilities, to determine the real intentions of the principals behind the plaintiff. Although this is a very subjective exercise to say the least, the Court must examine the objective facts to arrive at such a determination. New winds have not been blowing along the judicial trail in so far as this issue is concerned. It is a question of fact.
The first conclusion to be drawn from the facts as pleaded is that the acquisitions of the shares were an isolated transaction. I will comment on the evidence later but the pleadings are clear in their wording. However, it has been held that the singleness or isolation of a transaction is not conclusive on whether or not it was an adventure in the nature of trade. It is a criterion amongst others; see generally on that MNR v Jones A Taylor, [1956-1960] Ex. CR 3; [1956] CTC 189. Similarly, the idea that the fact that a transaction is “different” in nature from any of the other activities of the taxpayer does not of itself take it out of the category of being an adventure in the nature of trade.
The case of MNR v Henry J Freud, [1969] S.C.R. 75; [1968] CTC 438, has also defeated the proposition that the acquisition of shares is necessarily an investment. This is how Pigeon, J phrased it at 80-81 (CTC 442):
It is clear that while an acquisition of shares may be an investment (MNR v Foreign Powers Securities Corp Ltd, [1967] S.C.R. 295). It may also be a trading operation depending upon circumstances (Asler Hammond and Nanton Ltd v MNR, [1963] S.C.R. 432; Hill-Clarke Frances Ltd v MNR, [1963] S.C.R. 452).
I am thus prepared to go as far as saying that the subject matter of the transaction is only an element to consider. Lord President Clyde put it succinctly and beautifully in Balgownie Land Trust, Ltd v CIR (1929), 14 TC 684
. . A single plunge may be enough provided it is shown to the satisfaction of the Court that the plunge is made in the waters of trade ..
Can it be sustained that the plaintiff's avowed intention to resell for a profit is a sufficient test?
In delivering the majority judgment in the case of Irrigation Industries Ltd v MNR, [1962] S.C.R. 346; [1962] CTC 215, Martland, J commented on page 351 (CTC 219) on the appellant’s intention to sell the shares at a profit as soon as is possible:
In my opinion, a person who puts money into a business enterprise by the purchase of the shares of a company on an isolated occasion, and not as part of his regular business, cannot be said to have engaged in an adventure in the nature of trade merely because the purchase was speculative in that, at that time, he did not intend to hold the shares indefinitely, but intended, if possible, to sell them at a profit as soon as he reasonably could. I think that there must be clearer indications of “trade” than this before it can be said that there has been an adventure in the nature of trade.
And finally on page 355 (CTC 223):
The only test which was applied in the present case was whether the appellant entered into the transaction with the intention of disposing of the shares at a profit so soon as there was a reasonable opportunity of so doing. Is that a sufficient test for determining whether or not this transaction constitutes an adventure in the nature of trade? I do not think that, standing alone, it is sufficient.
It should be noticed that Irrigation Industries bought “treasury” shares (not on the market) and here the plaintiff bought what could be termed as “corporate” shares. As Mr Justice Collier said in Bossin v The Queen, [1976] CTC 358 at 368; 76 DTC 6196 at 6201: “the distinction in facts is not conclusive in any way . . .”.
It becomes apparent that the intention of selling the shares at a profit is thus inconclusive. As disclosed in the statement of claim and in the statement of defence, it is relatively safe to conclude that the plaintiff was not engaged in the business of dealing with securities. I therefore assume prima facie that the plaintiff, through its directing minds, could indeed have intended from the time it acquired the shares to sell them at a profit as quickly as possible. Only two events had to be satisfied before the plaintiff could sell the shares of Bad Boy Limited: the full utilization of Bad Boy Limited's non-capital losses account, and the turning of Bad Boy Limited into a profitable enterprise again (which undoubtedly would increase the value of its shares). This scheme is highly plausible and if profitable would certainly attract a different tax treatment than the one adopted by the Minister. This last statement is probably gratuitous but experience has proven that such is often the case. Since this scenario did not come about I am now called upon to determine if indeed this scheme was intended by the controlling minds of the plaintiff at the time the shares of Bad Boy Limited were purchased.
It is appropriate at this juncture to turn to the evidence which reveals more information and more detail than do the pleadings.
Mr Jerry Van was called by the plaintiff. He was at the time of the acquisitions the president of the plaintiff, had some 17 years' experience in the carpet business, and was associated with the plaintiff from about 1970. We learn from Mr Van that in the carpet retail business (and this can be said of most retail businesses) they had a real concern about supply of product from their manufacturers. Indeed he indicated that some manufacturers were loathe to supply the plaintiff because of discounting deals they were able to make, thereby selling for less than other retailers who were also customers of the manufacturers. Because of this they determined it was a golden opportunity when shares in Toronto Carpet (later called Barrymore) became available. By purchasing these shares they owned a manufacturing company capable of providing the merchandise required by the plaintiff, in short, a measure of vertical integration. Some rationalizing was done and the shares in this private company are still held today by the plaintiff. The plaintiff probably could not survive without an assured supply, thus a good reason for holding on to the shares and control of Barrymore. The intention of the plaintiff in this transaction was clear, the reason for purchase was evident, and the reason for not reselling even for profit is obvious — the plaintiff needs Barrymore.
I can see the purchase of Bad Boy Limited shares as analogous possibly but certainly not comparable. Mr Van was a positive, credible witness and most consistent in his testimony — even to admitting or conceding in cross- examination that neither Talcorp nor the Bank of Montreal were told his and his partner's ultimate aim was to realize "every businessman's dream” — liquidity. Sell and get out. I see nothing heinous or even inappropriate in this. Provision was made in the memorandum of agreement that if Mr Van sold and left the firm he would not carry on this kind of business for five years. Also, one of the documents clearly indicates new management was contemplated and that Mr Van would not be running the operation as president and chief executive officer.
His evidence was remarkably coherent for such a large and complicated transaction. He was convincing throughout and never wavered under excellent cross-examination. He conceded his surprise at the extent of the losses of Bad Boy Limited over and above the amount he thought they were.
It is also interesting to note that Trucena, the company originally approached to participate in the acquisition of shares, were not prepared, after careful consideration, to participate unless Mr Van committed himself to a term as chief executive officer. Mr Van would not make that commitment but one cannot help but feel that if Mr Van had “stayed on board” then Trucena would have entered into agreement with the plaintiff — solid confidence indeed in Mr Van.
Mr Van was most consistent, as I've said earlier. His evidence is that Factory Carpet was a very successful enterprise. Prior to the purchase of the shares in Bad Boy Limited they had been giving serious thought to becoming a public company. Through some inside information they heard that Mr Lastman’s shares might become available for a price of $3.76 per share. Mr Van's evidence is that they were excited and intrigued by the opportunity. To him this would enable them to meet business objectives, namely go public, and to gain dollars, and if they turned Bad Boy Limited around, could sell and gain that all-too-often elusive “liquidity”. As businessmen, they examined the records available to the public, and because a $500,000 loss was shown over a period of some months, they decided to cover that situation by offering $3 per share rather than the $3.76. Mr Van conceded that although the plaintiff was successful and earned $1.8 million per year, there was little hope of gaining the liquidity sought unless they went public, thus the reason for buying shares of the public company.
The answers to “why purchase” seem quite clear therefore, if one examines Mr Van's evidence. They were contemplating going public with Factory Carpet Ltd but it was expensive and usually the market is looking for corporations that have been in business for periods in excess of 5 years, even a very successful business. Purchasing the shares of the public company Bad Boy Limited gave them another route.
Also, Bad Boy Limited had significant non-capital losses available to enable the plaintiff to "shelter” from income tax the profits of the plaintiff. Going public gave them a ready market for their shares.
Mr Van stated they saw several opportunities to increase substantially the value of Bad Boy Limited. Aside from providing outlets to Factory Carpet Ltd in areas where they had none, they would be able to rationalize Bad Boy Limited in several ways. He mentioned selling off or closing unprofitable outlets, and in other areas complement furniture and appliance stores with Factory Carpet Ltd product. He felt the marketing method used by Bad Boy Limited was inefficient and costly but could be turned around in two or three years. It is clear Mr Van and his partners had the business acumen to turn Bad Boy Limited around. The roadblock to this happening was the financial information subsequently received that the figure $500,000 was incorrect. The actual figure turned out to be around $2 million.
Counsel for the defendant argued, and endeavoured in cross-examination to suggest, the shares could not be sold because the shareholders agreement was the same as the earlier Toronto Carpet/Barrymore agreement. Not so, pointed out Mr Van because of the words "where applicable” in the memorandum and the fact that Barrymore was a private company whereas Bad Boy Limited was a public company, shares being traded on the exchange. Also, Taicorp was really in a no-lose situation due to the put option and the personal guarantee they insisted on having (so did the Bank of Montreal). The main reason for "adopting” such a measure "where applicable” without spelling everything out in detail was the time factor — speed was of the essence.
By rolling in Factory Carpet Ltd, after the shares had been acquired, it would enable them to pay off Talcorp and the Bank of Montreal and secure a release from the personal guarantees given by the principals.
I am satisfied that the two transactions Barrymore and Bad Boy Limited are separate and not comparable. For the reasons given earlier, it was clear the taxpayer must retain the shares of Barrymore.
In the transaction involving Bad Boy Limited no such situation exists. Clearly there are objective indications for accepting the intention of the principals — the taxpayer. Mr Van had 17 years in the carpet business and wanted out. He also wanted liquidity and had considered the possibility of making the taxpayer a public company. His recital of the problems involved when a "new” or "short history” company seeks to go public are straightforward and in my view correct. The fact of considering going public lends credence to the taxpayer’s intention that the principals were seeking liquidity — sell and move on to something else. Purchasing the shares of Bad Boy Limited, a public company, using their non-capital losses, rationalizing, and reorganizing, are all consistent with the intention to turn the company around, make it more profitable and thereby increase the value of the shares, plus the probability of enticing other shareholders to invest, ie buy shares enabling this public company to succeed. Mr Van's evidence was that two to three years should do it even given his knowledge of the loss of $500,000. Despite the eventual information that the loss approached $2 million the principals sought means to save Bad Boy Limited. It became obvious that saving the company was impossible. From the outset the principals were involved in the enterprise and were prepared to roll in the shares of Factory Carpet, to risk a year’s earnings of the taxpayer’s $1.8 million and to work two to three years to turn it around before selling the shares, placing them in a liquid position. It is all consistent with the intentions expressed by Mr Van in evidence.
Counsel for the defendant cited Becker v The Queen, [1983] CTC 11; 83 DTC 5032. I will not spell out the “facts” for they are available to those who wish to read the case. Suffice it to say that the trial judge's decision was overturned by the Appeal Court who found the transaction there an adventure in the nature of trade. It is true that the taxpayer here did not have to sell but its clear intention was to sell.
In my view the decision of the Federal Court of Appeal is applicable to the present case. Mr Justice Le Dain, in distinguishing the Irrigation case, has elaborated what I believe to be a useful criterion to resolve the matter in dispute. The criterion can be conveniently referred to as the "enhancement" criterion. In the Irrigation case the controlling minds behind the company did nothing to enhance the value of the shares. They simply bought them, held them and sold them at a profit. This is what Mr Justice Le Dain said in the Becker case (supra) at 14 (DTC 5034):
An important difference between Irrigation Industries and the present case is that the BCP venture did not simply involve a purchase of shares with an intention to resell them for a profit, but the purchase of a business with the intention of transforming it in order to turn it into a profitable enterprise.
[Emphasis is mine] and later at 14 (DTC 5035):
The appellant did not say that he intended to sell the business “eventually", thereby implying that his immediate or motivating intention in purchasing it was to retain it for the purpose of earning income. He said that he could not keep the business and that he never intended to recover his investment by income from the business. In my opinion, if the appellant's testimony is to be taken as credible by this Court in view of the position taken by the Trial Judge on the question of credibility, there is only one conclusion that can properly be drawn from it, and that is, that it was the appellant’s intention, upon changing the nature of BCP’s business and making it profitable, to sell it as soon as possible for a profit.
Similarly, it is edifying to quote still further at 14 (DTC 5035):
This brings the case in my opinion within the conception of adventure in the nature of trade that was applied in Commissioners of Inland Revenue v Livingstone (1926), 11 TC 538. That case involved an isolated instance in which the taxpayers purchased a ship and changed its character with a view to selling it for a profit. The test that was applied was whether the operations involved in the venture were of the same kind and carried on in the same way as those which were characteristic of ordinary trading in the line of business in which the venture was made. It was said: “The profit made by the venture arose, not from the mere appreciation of the capital value of an isolated purchase for resale, but from the expenditure on the subject purchased of money laid out upon it for the purpose of making it marketable at a profit. That seems to me of the very essence of trade.
I am satisfied the necessary inferences can be drawn that paragraph 9 of the statement of claim is true, and am satisfied it shows that the plaintiffs "intended" scheme was its hope to turn the fortunes of Bad Boy Limited around. The turning of the investment to account was the motivating factor to the transaction, and thus it was an adventure in the nature of trade. The fact that losses were incurred in the instant case makes no difference since, as stated by Mr Justice Pigeon in the Freud case (supra):
Such being the principles to be applied in cases when a profit is obtained, the same rules must be followed when a loss is suffered. Fairness to the taxpayers requires us to be very careful to avoid allowing profits to be taxed as income but losses treated as on account of capital and therefore not deductible from income when the situation is essentially the same.
Just prior to the trial, counsel for the defendant moved with consent of the plaintiff to amend the statement of defence in paragraph 9 of action T-2779-81 and paragraph 12 of the statement of defence in T-1717-83 so they now read:
T-2779-81 — Paragraph of Statement of Defence:
He submits, in the alternative, that as the 600,000 shares of Bad Boy Limited were not sold, cancelled, destroyed, or otherwise disposed of in the 1977 taxation year, no loss arose in respect of them in that taxation year.
T-1717-83 — Paragraph 12 of Statement of Defence:
He submits, in the alternative, that as the 600,000 shares of Bad Boy Limited purchased from Taicorp Association Ltd were not sold, cancelled, destroyed, or otherwise disposed of in the 1978 or 1979 taxation years no loss arose in respect of them in those taxation years.
This alternative argument was advanced but I see no real merit in it. The value of the shares was nil as a result of the fact that Bad Boy Limited was in receivership. What is added by selling for $1 or physically destroying the shares? By accepting this defence the Court would, in my view, be simply delaying the inevitability of such an action taking place, and a claim made in another year. There is no doubt the shares had no value and the fact of their being physically in place in the possession of the taxpayer cannot detract from that.
Also, it should be noted that the venture was shown under a heading "Investments" in the financial statement of the company and later after discussions with company officials and legal counsel, it was shown as:
"Income before extraordinary item
Less: Loss on inventory of Bad Boy Appliances and Furniture Limited, net of income taxes — Note 7”. Note 7 reads:
7. Extraordinary Item:
The company’s venture in the acquisition of Bad Boy Appliances and Furniture Limited’s shares became worthless in 1977. On August 18, 1977 a receiving order was made under the Bankruptcy Act against Bad Boy, the result of which was that the shares could no longer be sold and the company has been advised that there will be no funds available for shareholders as a result of the liquidation of Bad Boy.
This entry was carried in the same fashion for succeeding years. Mr Sacks, the accountant responsible, was called to explain. He indicated that the auditor's report had been prepared by "our office" and he was a partner in the firm and did the work with two or three others. To him investment was used in an accounting and not a legal sense. An explanation was necessary, and he referred the court to page one of the auditor's report dated March 6, 1977 which reads in part: "As disclosed in Note 9, we have not been able to determine whether there has been a reduction in the value of the shares in Bad Boy Appliances and Furniture Limited”. Note 9 reads:
9. The audited financial statements of Bad Boy Appliances and Furniture Limited for the 39 week period ended January 1, 1977 reflect a net loss of $1,964,628 and a book value of $4,567,611. As a result of this, and because the investment represents a block of shares, the market value of these shares cannot be determined.
Given this information and the evidence of Mr Sacks, use of the word investment is not conclusive or binding on what I see as the clear intentions of the principals, and the subsequent manner in which the shares are shown in the auditor's report better indicates the true status for tax purposes of the shares, as an “extraordinary item” which better met the criteria of his governing accounting body as he understood it.
For the reasons given I am of the opinion that what the principals/tax- payer did with respect to Bad Boy Limited was an adventure in the nature of trade and the loss which resulted was a business loss which is properly deductible in the computation of the taxpayer's income.
I therefore vacate the reassessment dated February 25, 1981, and direct it be referred to the Minister of National Revenue for reconsideration and reassessment so as to allow the deduction claimed by the plaintiff as a noncapital loss in respect of the sum of $1,841,783 in computing its income for the 1977 taxation year.
I therefore vacate the reassessment dated November 9, 1982 for the 1978 taxation year and direct that it be referred back to the Minister of National Revenue for reconsideration and reassessment so as to allow the deduction of the non-capital loss as claimed by the plaintiff in respect of the sum of $1,650,080 for its 1978 taxation year and the loss carry-forward of $1,564,144 for its 1977 taxation year. I further direct that the reassessment dated November 9, 1982 for the 1979 taxation year be referred back to the Minister of National Revenue for reconsideration and reassessment so as to allow the deduction of the non-capital losses carry-forward as calculated by the plaintiff for its 1979 taxation year.
The plaintiff is entitled to its costs of this action.
Appeal allowed.